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How should an investor deal with good and bad market phases?

As long as the portfolio value is above this number, it is behaving exactly as it should. This is the normal expected behaviour from one’s portfolio.

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This way, you will be able to put the common yearly temporary declines into proper perspective and also won’t be surprised by them.

Short-term ups and downs happen time and again in the stock market. Hence, it is important for an investor to understand these market cycles, be prepared, and not be surprised when a downturn occurs.

Here are some important points to keep in mind while dealing with both good and bad market phases:

Set the expectations right
Normally, investors should expect 10 to 20 per cent temporary corrections every year.

Arun Kumar, Head of Research, FundsIndia, says, “When one checks one’s portfolio, he/she should assume 80 per cent of their equity portfolio value and add that to the debt portion’s value. Mentally, one should benchmark the value of their overall portfolio to this number. As long as the portfolio value is above this number, it is behaving exactly as it should. This is the normal expected behaviour from one’s portfolio.”

He further adds, “This way, one will be able to put the common yearly temporary declines into proper perspective and also won’t be surprised by them. One should also make sure that the allocation of funds is in line with one’s ability to tolerate declines.”

Plan of action

As equity markets have had significant returns in the recent past, Kumar points out, “there is a high likelihood that one’s equity exposure has exceeded the originally planned asset allocation levels by more than 5 per cent. If yes, this is a good time to rebalance and reduce the equity exposure back to the originally planned exposure.”

Make plans for different situations

If equity markets go up around 0-20 per cent during the next one year, which is the baseline expectation from equity markets, experts say the returns are positive and as per expectation. Hence, no action is required. You can then continue with your original asset allocation plan.

However, if equity markets decline around 0-20 per cent during the next one year—which is normal for equity markets to have temporary declines of 0-20 per cent almost every year, again no action is required as this is expected as a part of the original asset allocation decision.

But if equity markets are in a crisis and declines more than 20 per cent during the next one year, Kumar says, “it indicates a bear market and is generally the best buying opportunity. Investors can plan to rebalance back to their original asset allocation by selling debt and increasing equity at intervals of, say, every 10 per cent fall.

He further adds, “And if equity markets rally and go up more than 20 per cent over the next one year it may lead to equity exposure that is higher than the originally planned allocation level. This can be a good time for rebalancing—by reducing equity back to its original asset allocation and moving it into debt.”

With market-linked investments, trying to predict the direction of the equity markets consistently over the short term is a difficult task. According to experts, as an investor, you need to set the right expectations and once this is done, put in place a pre-planned action plan. This way, “you will be able to manage your portfolios across both good and bad market phases without getting overly aggressive or panicked,” adds Kumar.

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